Identiv Inc (INVE) 2003 Q1 法說會逐字稿

Ladies and gentlemen thank you for standing by and welcome to the SCM Microsystems first quarter earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question, please press the one followed by the four on your telephone. As a reminder, this conference is being recorded Thursday, April 24th, 2003. I would now like to turn the conference over to Ms. Darby Dye, Director of Investor Relations. Please go ahead M'am.

Thank you. Hello everyone and thank you for joining us today as we discuss the results of SCM first quarter of 2003. Speaking on today's call are Andrew Warner, Chief Financial Officer who will provide financial analysis of SCM's recent quarter as well as forward-looking financial guidance and Robert Schneider, Chief Executive Officer who will provide an overview of SCM's market environment and business strategy.

As we begin today's call, let me remind you that during the course of this conference call management will make certain forward-looking statements regarding future events or the future financial performance of the company. We caution you that such statements involve risks and that actual events or results may differ materially. We refer you to the company's 10-K and recent SEC filings, which explains several important factors that could cause actual results to differ from those contained in any projections or forward-looking statements.

Any forward-looking statements made on this call are based on information that is currently available and which is likely to change over time. Although our projections will likely change, we do not plan to update them. SCM will provide our analysts and investors with information and forward-looking guidance in our quarterly financial news releases and conference calls as well as 8-K filings. We will not provide any further guidance during the quarter and unless done through the news release, conference call or SEC filing in accordance with Regulation Fair Disclosure. On a final note, today's call will provide you with several financial metrics determined on a non-GAAP or pro forma basis. These items together with the corresponding GAAP numbers and a reconciliation to GAAP are practicable are contained in today's earnings press release, which we have posted on our website at scmmicro.com and filed with the SEC on Form 8-K. Now, I'd like to introduce Andrew Warner.

Thank you Darby. The results of our first quarter were in line with guidance we gave in February, reflecting an economic environment that continues to be challenging. So, let's start with an overview of the numbers. We reported revenues of $31m in Q1 within the range of guidance we gave for the quarter of between $31m and $36m. Total revenues were down 29% from $43.4m recorded in the first quarter of 2002 and down 35% sequentially from revenues of $48.4m in Q4 2002. Our results effect decreased sales of both our security and our Digital Media and video products. Gross margin for Q1 was 31% in line with our target gross margin for the quarter of 30%.

Underlying operating expenses came in at $13.6m down 10% from expense level of $15.1m in the fourth quarter - excluding amortization of intangibles, restructuring, stock-based compensation expenses and infrequent charges which totaled approximately $835,000. We had an operating loss of $3.9m in Q1 this was consistent with the range of guidance we gave for an operating loss between $4m and $6m. Including these icons our operating loss as reported in accordance with GAAP was $4.7m.

I'll provide a more detailed analysis of operating expenses and infrequent charges in a moment. But first let's look at our performance on a divisional basis. Revenues from our Digital Media and Video business were $14.9m, slightly below the range of guidance we had set of $16m to $19m. This represents a decrease of 29% from sales of $21m for the first quarter of 2002 and a sequential decrease of 47% the $28m we recorded in Q4 2002. Revenues from this division comes from sales of our Digital Media Reader-Writers, as well as from sales our Video Capture from editing products. Both product lines are sold under the Dazzle brand into the retail channel as well as the OEM customers in the PC OEM and consumer electronic industry.

Digital Media and Video sales in Q1 reflect seasonally lower demands as well as a weaker retail market environment, particularly in North America and in the UK. While the competitive environment continues to grow more challenging, our market position held strong during the quarter with the Dazzle brand maintaining market share in all categories. Gross margin for the Digital Media and Video division was 20% in the first quarter, below our target of 25%. Gross margin impacted both by the lower level of revenues in the quarter as well as high redemption rates on the rebate programs run during the quarter. Operating expenses for the division were $6.5m, resulting in an uprising loss of $3.5m.

Revenues from our security business was $16.1m in the first quarter within the range of guidance we had indicated between $15m to $17m. This represents a decrease of 28% from sales of $22.4m in the first quarter of 2002 and a sequential decrease of 21% on a $20.5m we record against Q4 2002. Revenues in our security division consist of sales of smart card reader, these to provide physical and network access and conditional access modules for the digital TV market. As expected, sales in our smart card reader products declined in Q1, from levels in previous quarters as projects relating to US government's Common Access Card Program slowdown. SCM is a significant supplier of smart card readers for the Common Access Card and the lease in course have experienced strong sales from this program. However, going into calendar 2003, many of our partners who contract directly with the government share with us their forecast, which indicated the pace of program deployment was slowing. This impacted our revenue levels in our security division in Q1.

As we have said before, orders under this government program tend to be large, but variable in terms of timing resulting in revenue variability on the quarterly basis. Based on our forecast concerned with the timing of upcoming orders, we expect that sales of our smart card readers will remain at the lower levels in the near-term. On the digital TV side, our sales levels have recovered from the shortfall we experienced in Q3 of last year, but they remained below the levels we experienced a year-ago. The majority of our digital TV product sales are made in Europe where it's clearly a defined market for our needable (ph) security devices to decrypt digital television broadcast signals. However, the weak economic environment in Europe continues to downturn consumer demands for digital TV services and many television operators are experiencing financial difficulties after years of subsidizing set-top boxes for their subscribers.

We believe this situation will result overtime as these same economic pressures host operated to adopt more cost-effective delivery systems, which our modules provide. Bob will provide further commentary on the dynamics in this market in a few moments. Gross margin in our security business came in at 42% for the quarter above our guidance of 40%. Operating expenses for the security division was $7.2m resulting in an uprising loss of the $400,000. Now looking at revenue split by geography: the US represented 43%, Europe 44% and Asia-Pacific 13% total Q1 revenue. Turning to operating expenses, total operating expenses in Q1 excluding the amortization of intangibles, stock-based compensation expense, restructuring and other infrequent charges with $13.6m, down 10% from the $15.1m we recorded in Q4 and up slightly from the $13.3m in expenses we recorded in Q1 2002.

Underlying operating expenses represent 44% of revenue. Looking at the main expense line items, research and development expenses were $3.5m for the quarter, sales and marketing expenses $7m, and general and administrative stood at $3.1m. On an ongoing basis, we will continue to evaluate ways to lower our base line expenses across both divisions in pursuit of increasing efficiencies in our business. Amortization of intangibles was $409,000 in Q1 and we expect the quarterly amortization expenses to remain around this level going forward. We recorded restructuring stock-based compensation expenses and other infrequent charges are $426,000 plus. Q1 interest and other capital gain of $1.1m resulting from interest income that was augmented by our foreign exchange gain and we have recorded tax provision of $106,000 in the quarter.

SCM's net loss for the first quarter of 2003 as reported in the current [Inaudible] with GAAP is $3.7m or $0.24 per share. This compared with a reported net income of $113,000 or $0.01 per share on the year ago. On a pro forma basis, the net loss for the quarter is $2.9m or $0.19 per share excluding amortization of intangibles, restructuring, stock-based compensation expense and infrequent charges. This compares with pro forma net income of $1m or $0.06 per share in the first quarter of 2002.

Looking at guidance for the second quarter of 2003, we expect revenues from our security business to be in the range of $17m to $19m. This reflects continued near-term pressure on sales of our conditional access modules going to be TV (ph) markets as well as continued variability and five in coming (ph) of orders from the US government related to Common Access Card Program. We expect our margins for the security division to remain around 40%. We expect revenues from digital media and video business will be range of $14m to $16m for the second quarter reflecting a continuing challenging economic outlook, and we expect gross margins in the digital media and video division to remain around 20%.

On a combined basis there four weeks several company revenues will be in the range of $31m to $35m for the second quarter, year-end (ph) gross margins to remain around 30%. We also expect an operating loss for the second quarter in the range of $3m to $5m, it does exclude amortization of intangibles, stock-based compensation expense, and infrequent charges which we expect will total around $1m. To wrap up, let's take a look at the balance sheet. Cash and investments were at $55.9m at the end of Q1, this compares to $55.5m at the end of Q4 and we are pleased that we were actually able to increase cash slightly during the quarter despite our operational loss.

Preserving our cash position continues to be a key area of focus. Accounts receivables were $19.6m at the end of Q1 compared with $31.3m at the end of Q4, and inventory levels were $41m compared with $39.1m in the previous quarter. The higher inventory levels resulted from in the line low sales of Digital Media and Video products against [Inaudible] , within that division we have aggressive programs in place to manage down our inventory. This will continue to be an area focused for over the next few months and we will closely monitor the success of these programs in lowering our inventory level. Day sales outstanding at the end of Q1 was 58 days compared with 59 days at the end of Q4 and 84 days in a year ago quarter. With that I would now turn the call over to Robert.

Thank you Andrew. In Q1 we performed to plan and what has continued to be a difficult economic environment. Our revenue gross margin and up holding performance were inline with our expectations and we preserved cashes, Andrew just mentioned even growing our cash position during the quarter. We also continue to reinforce and expand our key business strengths, which include our technology portfolio, our customer relationships and our market share position. Underneath the economy is difficult situation to have viable market opportunities in the areas of Digital Television, [Inaudible] network and physical access control, e-Business and e-Government. And it is SCM's goal to develop those opportunities now so that when investments are renewed and budgets are again loosened, we will be in the sound position to benefit from the goals that these markets offer.

Today, I would like to give you an update on the SCM's current market position and share with you the reasons why we remain very positive about the future of this markets, and confident of SCM's ability to capitalize on each of them over the long-term. First the Digital TV market, as I discussed with you in our call in February that Digital TV market in Europe currently is in a state of profound transition moving from a closed business and technology model to an open system that dramatically reduces capital costs for operators. Macro economic conditions for operators in [Inaudible] increasingly difficult, market goals have slowed, considerable for pay TV operators and several large operators have lost a substantial number of subscribers over the last year. As a result many operators are no longer able to bare the financial burden of holding out expenses for prior day receptive bucks to each subscriber.

We must adopt a more cost effective way to deliver services or go out of the business. On that way of standardization of costs and consumer industry including Philips, Sony, and Panasonic are supporting our technology. SCM offers digital TV operators are more cost efficient deliver the module with our conditional access conditional modules which slot into an open system's set-top box supplied to the subscriber rather than the operator to [Inaudible] both cost (ph) content. We believe that European digital TV operators will adopt an open system support over time as their financial pressures on them increase. When they do so, SCM intends to be the company supplying them with removable security in the form of our conditional access modules.

We had supplied so far, over 6 million modules to date, that to smaller operators who are at Europe and in the last several months have signed one of the largest operators in Europe as a customer. We are the unchallenged market leader in this technology worldwide. We are still at the beginning of this adoption curve of our removal of security technology and so realistically we do not expect this transition to dramatically hold our business in the near term. However it is SCM's experience and understanding of the development of the European digital TV market which has earned us blaze of the table in other developing markets like US and specifically I will say Korea. In the US a major industry breaks (ph) have occurred in December when the National Cable Television Association and a group of leading consumer electronic companies agreed to adopt the US Open Cable Standard for removal of the security as a way to open the market for new cable or digital television sets.

In order to be operable anywhere in the country the new TV's must use a port called a point of deployment modules identical, almost identical to European conditional access modules and this is the open standards supported removable module, which is defined by open cable. So, the industry in the US is moving in the [Inaudible]. As you know SCM helped to develop the ports standards and is the only independent company that understands to open cable environment for this reason. In March of this year SCM was invited to speak at a special hearing of the Federal Communications Commission in Washington to give our perspective on why and how the port (ph) modules should be implemented in the US markets. This recognition by the FCC of SCM's technical and market [Inaudible] on digital TV environment was a significant accomplishment for us and it gave us a very good image with all cable operators in the US.

We will -- I also guess it will work into strengthen our relations with consumer electronics companies such as Philips, Samsung, and Sony, who will drive demand for POD (ph) modules in the US market. This POD is part of our strategy to work with these partners SCM will be providing a next generation tests, tool and test equipments to consumer electronics companies, conditional access providers, and cable operators that allows them to rapidly develop open cable compliant products and then I am sure that interoperability with other systems. This tool is a hardware and the software will be also used by cable that switches -- which manages the open cable specifications and this fee certification authority for the standards within a couple of months -- couple of weeks during few one of the -- we shipped product, we had basically whole consumer industry ordering initial test tools from us.

It is unclear whether the US digital television market will come truly open on removal of security technology however, if does as same plans to participate. Our recognition by the FCC and our ongoing work was cabled at the conditional access suppliers and consumer electronic companies are significant indications that we are positioning ourselves appropriately at these markets, market unfolds. In Asia and here specifically in Korea there is a more clear cut market developing, markets developing for removal of security technology to Korean government, the FCC equivalent has mandated the use of removable security modules as part of the countries conversion to Digital television technology in the cable operator -- in the cable operator markets. And government expects to all our digital cable TV to between 5 million and 8 million Korean households within next five years.

Korea's digital broadcasting systems will be based on the US open cable specification, which SCM helped to develop. Based on our experience in Europe, European digital TV industry and our experience with open cable SCM has been working with various partners in Korea to prepare for the launch of digital cable. We had been working with both local and leading global conditional access providers like NDS, [Inaudible] , to port their security system to our port modules. In order to ensure and probability with various set-top box manufactures and specifically LG and Samsung which have been leaders, leading consumer companies in Korean and home market of course.

In April this year, we successfully demonstrated our port platform running various partners conditional access systems with set-top box manufacturers as mentioned before. We have also been working with Korea's seven major cable operators to test and validate the system with open cable specifications and to ensure the readiness to move forward. Overall the Korean program has been moving forward smoothly and rapidly. And, the industry plans to begin those in the second half of this year, with the first commercial deployments taking place in 2004. For SCM, the revenue opportunities in the Korean market does not really begin until 2004 the earliest, but when Korea does begin to deploy conditional access modules in the millions of units SCM will be in the best position to participate in this opportunity. Over the next 5 to 8 years, we believe the inevitable switch from analog to digital as well as the industry welcome business models of proprietary platforms will be a major force under the vision to open standards. The platforms, which will provide significant worldwide opportunity for SCM.

Turning to our second market segment PC Security. Those of you follow SCM are aware over the last year and half, SCM has been significant supplier of Smart Card Readers and the reader technology to the US government, for securing access to computer networks. Working with government primes, system integrators, and strategic partners including Schlumberger, Northrop Grumman, and ActiveCard, we have supplied over 1 million readers for the department for the defense Common Access Card program. Under this program the DOD is providing a personal ID card, for more than 4 million personnel. Using our readers the card is being is used for secure network access, E-Government applications and eventually physical building access as well. This is the largest deployment of a public key infrastructure program in history. And we are the major supplier on the Smart Card Reader market there.

As Andrew indicated before, in the near term we expect to ship few Readers for the Common Access Card program, as over the next several months there are few project deployments planed than in previous periods. It is also unclear whether budgets will disrupted due to spending on the war in Iraq. SCM's hold in this program remains unchallenged and we expect that when projects resume we will be a part of them. Over the longer term there are additional government Smart Card initiatives under consideration that could further expand our opportunities in the US, for example the transport worker ID cards is in an initiative of the US transportation administration to secure all transportation areas. Over the next three years to the use of 15, so the BOD is overall a 4 million person project which is now into a deployment of about 2 million.

The transport workers administration project is potential of 15 million workers at airports and seaports, railways, bus lines, and will be issued identification cards to provide authentication and also as access to sensitive areas and data Smart Card pilot programs for this program are beginning and SCM is actively engaged in this pilots with the match (ph) government contractors. In the corporate sector, SCM is working closely with companies such as [Inaudible] , Hewlett Packard, Sun and Microsoft, not only to incorporate support for Smart Cards in their platforms but to implement Smart Card based systems for their internal security needs as well. These internal programs can be seen as pilots for markets are expected to remain under budget constraints. And for SCM, the expansion of IT budgets will signal as a significant opportunity to capitalize on the relationships and the market leadership we've established with the key players.

Finally, in the financial sector, we continue to work both sides (ph) with customers and sole partners such as Schlumberger to supply banks with Smart Card readers for their emerging electronics service offerings. With the Europe the international banking community is moving forward aggressively to adopt secure online banking. In Germany, we've began pilot programs with several major banks to deliver and test a new class of secure reader with the banks plan to deploy to the customers for enabled secure home banking applications.

We are able to secure this pilots because of our demonstrated commitments to various industry and technology standards, which are becoming an ever more critical component of financial applications based on Smart Cards. In the first quarter, we received two major certifications for our readers, which are critical to mainframe financial applications. The first was EMV, which stands for Europay MasterCard Visa. So, EMV certification for our Mobile readers, which means that our readers can be used in notebook computers to conduct secure financial transactions. SCM's PC Card readers are the only EMV certified readers on the marketplace.

We also received so called common criteria certification for our Smart Card/ PIN Pad readers, which guarantees compliance with the international requirement for digital signatures essential for conducting business in the global environment. The set of standards known as common criteria are used to evaluate IT solutions for compliance with stringent industry standards based on defined assurance levels. SCM's the first smart card reader manufacturer to receive a Level 3 certification which is the highest level of tested assurance for any smart card reader today.

So whether we are talking about opportunity in the government sector, which is happening now, or in the enterprise and financial sectors which are more long-term volume opportunities. SCM is extremely well positioned to capitalize on increasing demand for smart card reader technology, our products and technology, our experience in market share leadership and our strong partnerships across the smart card industry, prepare us to win smart card reader business as these market opportunities to develop.

Finally, let's take a look at the status of our separation plan for the DMV business from the security business. As you know at the beginning of 2002, we announced our intention to separate the Digital Media and Video divisions who have failed or spin off in order to more fully focus on our security business for digital TV and PC platforms. Over to last year, we have completed the legal and logistical separation of this business, but the state of the capital markets has made it difficult to accomplish the last phase of this separation to actual divestiture. We continue to monitor the receptive sales of the markets and are confident that we can make more progress.

In summary, SCM benefits from a strong market presence and strong financial position. In spite of the challenging economy we are preserving our cash, and today have a cash position of nearly $56m with no debt. We have the means to sustain our operations and support investments in opportunities that can realize significant shareholder value in the future. Given our strong market position and balance sheet we believe the company's stock remain significantly under valued. We continue to evaluate stock repurchase [Inaudible] and will remain focused on improving shareholder value while balancing our desire to preserve value cash assets. Now I would like to turn the call over to the operator for question and answers.

Thank you. Ladies and gentlemen if you would like to register a question, please press the one followed by the four on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the three. If you're using a speakerphone, please lift the handset before entering your request. One moment please for the first question. Our first question comes from the line of Kristin (ph) Decker with Commerce Bank Securities. Please go ahead.

Hi folks. This is Kristin (ph) . It's a short question on the receivable level. Did you do any factoring? Did you sell receivables to banks or is that all operational? Thank you.

Kristin, Andrew. Yeah that's all operational there's no factoring or sales of receivables.

Thank you very much.

Thanks.

Again ladies and gentlemen, if you do have a question or a comment at this time, please press the one followed by the four on your telephone. Our next question comes from the line of Thomas Becker with HSBC. Please go ahead.

Yeah, just one question regarding the market security, we just say for the DOD program what is happening, is the program slowing down in general or is it just the seasonal effect, probably you can comment on that?

Yeah, I can give you a comment on this. There is always a seasonal effect. By the way that's true for all our business, so from the Q4 level to the Q1 level we have typically 20% to23% (ph) top, so that is most of the effect. However, there is some uncertainties on those power checks and the placement of new power checks and that is [Inaudible] with much as discussions in the US and the Iraq war, which we think will very quickly we'll be moving forward towards those decisions.

Basically, the DOD power check has been rolled out now to about half the employees and so we expect typical Q3 and Q4 out of the best two quarters for deployment and we think this will continue, but of course the growth rate will not be that strong, it has been very strong last year and this year it will be more flat. And the new power checks which is not DOD but it's transport, and airports and seaports, that will start mid next year. So we see a next level of revenue increase coming mid next year there and this year will be reasonably flat, but it's up, it's not discontinued, so we certainly enjoy from our market position there.

Probably one follow-up concerning the DMV business. This seems to be not only seasonal weakness, when I look at your Q1 figure it was around $50 million after Q4 and more, what's the point there, why is it down so sharply?

Yeah, as you slice the cake down because of the weak overall environment, we saw significant reductions in volume activities both in the US as consumer spending dropped quite dramatically. We saw the same thing in Europe particularly in the UK. The interesting thing that is [Inaudible] in terms of our market share, we did not see significant drop in market share so our sense is that the market has fallen and we have fallen with the market, so we're not losing market share in the competition it is just that the market itself is weaker than we saw in Q4 and we fight the [Inaudible] .

Yeah. But is it fare to see whether there is, lets say, that there is fierce competition and fierce price pressure in the markets?

There is but again that would kind of - there was a dramatic impact of that and we would see that coming through with serious loss on market share. We are not saying that.

Okay. Thank you.

I am showing no further questions. Please continue with your presentation or any closing remark.

Thank you operator. In summary, we are confident in our ability to leverage our strong financial and market position to advantage of market opportunities, so would long-term. Thank you for joining us today.

Ladies and gentleman, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.